Should You Be Selling VIX Options? A Detailed Analysis. Theory vs reality
Maybe the worst product to trade
Should You Be Selling VIX Options? A Detailed Analysis
The VIX volatility index has long been a topic of interest among traders, especially when market volatility spikes suddenly. In this article, we'll analyze the history of selling VIX options, the associated risks, and strategies that could help manage these risks, with a particular focus on the difference between backtested results and real-world trading.
The History of Selling VIX Options
Since 2010, many traders have attempted to sell premiums on the VIX through various strategies, such as selling strangles, calls, and puts. The basic premise of these strategies is to capture the premium received by selling options and hope that volatility does not spike dramatically. However, while these strategies might seem straightforward in theory, the reality is far more complex and risky.
Profitability and Risk
When analyzing the historical results of selling VIX strangles and calls, we find that these strategies have been profitable on average. However, selling puts on the VIX generally resulted in breakeven or even negative performance. This is because, although the VIX tends to collapse or stay low most of the time, puts are priced accordingly, reflecting this behavior. Therefore, selling puts on the VIX is a challenging and often unprofitable strategy.
The biggest challenge in selling VIX premiums is the risk of significant losses during sudden spikes in volatility. For example, if you sell a strangle when the VIX is at 15 and it spikes to 80, you could face a loss of over $6,000 per contract. This risk is considerably higher than the average premium received, putting trading accounts in jeopardy, especially during periods of high volatility.
Reality vs. Backtest: A Crucial Comparison
One of the most important differences traders need to be aware of is the disparity between backtested results and real-world trading. In a backtest, you might see that selling VIX strangles and calls has historically been profitable, even in high-volatility scenarios. However, what these backtests fail to capture is the psychological and financial pressure of managing large mark-to-market losses during a volatility spike.
For example, in a simulated study, a strangle trade opened with the VIX at 15, and it spikes to 80, might show a maximum loss of $1,500, but not reflect the reality of a temporary loss of $6,000 if the VIX spikes from 15 to 80 in the middle of the trade (on a position that would only make $175). This discrepancy is critical because, in real life, traders might be forced to close positions at significant losses due to margin calls or emotional stress, whereas in a backtest these positions might have recovered and closed at a profit.
Risk Mitigation Strategies
Given the high risk associated with selling VIX premiums, one suggested strategy is using wide call spreads. While this strategy reduces potential profits, it also significantly limits possible losses. For example, instead of selling a naked call, you could sell a call and buy another call with a much higher strike. This protects you from the large losses that could occur if the VIX spikes.
Final Thoughts
The VIX is a complex product, and while selling premiums on this index can be profitable in certain scenarios, it also carries considerable risks. Losses can be much greater than the average figures indicate, especially during periods of high volatility. Therefore, it is essential for traders to fully understand the risks before implementing these strategies and consider using spreads or defined risk strategies to limit exposure.
In summary, while selling VIX options might appear attractive in a backtest, the reality of live trading presents significant challenges, particularly in terms of risk management and coping with temporary losses. For most retail investors, the VIX may not be the most suitable product due to its volatile nature and the significant risks it presents.